Treasury Wine Estates hits a cellar floor

Treasury Wine Estates has been on the back foot in the US since the start of the financial crisis. But this earnings downgrade could mark the beginning of its, and the industry's, recovery.

It is curious that Treasury Wine Estates should foreshadow $160 million of provisions and reduced US earnings even as the broad picture of the US wine market appears to be improving.

Treasury said today that while its earnings for the 2013 financial year were expected to be in line with market expectations it was working with its US distributors to address their excess, aged and deteriorating inventory. The actions included the destruction of old and aged stock, which could cost up to $35 million.

Another $40 million provision would be raised for extra discounts and rebates to accelerate the sale of excess vintage wines and a $85 million provision made for TWE's own excess bulk and finished wine and onerous grape contracts, while reduced shipments to the US could impact earnings by up to $30 million.

The US market – the world’s largest for wine consumption – has been a difficult one since the 2008 financial crisis, particularly for premium wines and for Australian producers had exacerbated the impact of over-planting and overproduction. Australian wine exports held up post-crisis but the value of those exports slumped sharply, with the strength of the Australian dollar compounding the problem.

The overproduction issue has been addressed in the past couple of years – about 5 per cent of the industry’s vines were removed – and the recent sharp fall in the value of the dollar will eventually flow through to better returns from exports.

There does, however, appear to be legacy issues within Treasury’s US wine business.

In the US during the aftermath of the crisis demand for wine held up but the average value of the wine being sold fell as the US entered recession. More recently, volumes and value have recovered but within a US distribution system that has been heavily rationalised in the past few years there is still a lot of excess inventory and the rate at which that inventory is being turned over has slowed significantly.

Treasury’s David Dearie today referred to the efforts by US distributors to significantly reduce targeted inventory levels but also conceded that Treasury itself had been overly ambitious in forecasting demand for new product launches and said the group believed old and obsolete product in the US was limiting its growth ambitions.

Treasury has traditionally, despite its ambition of being a premium producer, had a portfolio skewed towards lower price points in the US – the commercial wine category where volumes have been flat and competition is purely around price. Its US business was also quite reliant on the white zinfandel variety which isn’t as popular as it once was.

The growth in the US market appears to be in the premium wine segments, where there are price and volume gains occurring.

Getting rid of the excess inventory it and its distributors hold will not just help remove oversupply but should enable Treasury to reposition its offering towards the higher-growth segments.

In the longer term, the fundamentals for wine appear to have improved significantly.

Both the global oversupply which was a feature of the past several decades and the particular Australian oversupply position have been addressed and with demand for higher-quality wine again growing in the US, recent European grape harvests ravaged by adverse weather and Asian demand rising, the industry is shifting into a balanced supply-demand position and could even enter a period of wine shortage.

Coupled with a materially lower dollar, a far cleaner inventory position in the US and improved supply-demand dynamics, Treasury might finally be able to generate improved performance from a market that has been a difficult one for the group for much of its history.